Angel Oak Mortgage REIT, Inc. Q3 FY2022 Earnings Call

Greetings and welcome to Angel Oak Mortgage Third Quarter Earnings Conference Call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Randy Chrisman, Chief Marketing and Corporate Investor Relations Officer. Thank you, and over to you sir.

Good afternoon. Thank you for joining us today for Angel Oak Mortgage REIT’s third quarter 2022 earnings conference call. This morning we filed our press release detailing our third quarter 2022 results, which is available in the Investors Section on our website at www.angeloakreit.com. As a reminder, remarks made on today's conference call may include forward-looking statements. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those discussed today. We do not undertake any obligation to update our forward-looking statements in light of new information or future events. For a more detailed discussion of the factors that may affect the company's results, please refer to our earnings release for this quarter and to our most recent SEC filings. During this call, we will be discussing certain non-GAAP financial measures. More information about these non-GAAP financial measures and reconciliations to the most directly comparable GAAP financial measures are contained in our earnings release and SEC filings. This conference call is hosted by Angel Oak Mortgage REIT’s Chief Executive Officer, Sreeni Prabhu; Chief Financial Officer, Brandon Filson; and Angel Oak Capital's Co-CIO, Namit Sinha. Management will make some prepared comments, after which we will open up the call to your questions. Additionally, we recommend viewing our earnings supplement posted on our website at www.angeloakreit.com. Now, I will turn the call over to Sreeni.

Thank you, Randy, and thank you everyone for joining us today. Before I dive in, I would first like to express my sincere gratitude to Robert Williams, my predecessor as CEO, for his many contributions to both our launch as a publicly traded REIT, as well as his guidance to our first year post-IPO. Robert helped to set a strong foundation for the company, and I'm excited to lead the team through this next phase of its growth. As such, I will turn to our Q3 results and outlook. As you all know, 2022 has presented unprecedented challenges across financial markets and mortgage REITs, in particular, have felt the impact of many factors driving this instability. These challenges did not abate in Q3. Inflation remained elevated, forcing the Federal Reserve to persist with interest rate hikes, the base and the magnitude of which continue to cause widespread disruption across fixed income assets. Spreads have widened substantially, contributing to less liquidity in capital markets and conforming mortgage rates have more than doubled from about 3% a year ago to over 7% today. Consequently, mortgage originations have slowed during the third quarter as higher rates eliminated most of the benefit of refinancing and home sales slowed amid affordability concerns. However, there remains a meaningful shortage in the supply of quality housing across the country and unemployment remains low. Importantly, credit performance remains strong. Delinquencies are low, foreclosures are infrequent, and loss severity rates are near zero. For example, the percentage of loans in the AOMR portfolio that are 90-plus delinquent was 1.15% as of the end of Q3 and has trended downward each quarter since Q3 2020. It will come as no surprise that interest rate and spread volatility and the uncertainty had an impact on the AOMR portfolio in Q3. We faced downward pressure on our mark-to-market assets, which drove GAAP and economic book value declines of 27.8% and 19.4%, respectively. These book value declines are driven substantially by fair value marks associated with our whole loan, on-balance sheet securitization, and RMBS portfolios. I would like to emphasize that these marks represent unrealized losses. As I've consistently stated previously, the credit performance of these assets remains strong, and they're expected to pay off at par at which point, the mark-to-market losses would be offset. Given the current market, AOMR shifted to a more defensive strategy in Q3, managing liquidity while protecting our capital structure so that we are in a position to grow once markets and economic activity stabilize. We purchased fewer loans than in the previous quarters, though it is worth noting that the average coupon rate for these mortgage purchases was over 7%. And the Angel Oak Mortgage Lending, which is a sister mortgage company of Angel Oak, the most recent mortgage locks are over 8.5%. Over the coming quarters, we plan to reposition our portfolio to be more reflective of these current rates and to resume a methodical process of purchasing and securitizing newly originated high coupon loans. As part of the process, we'll evaluate loan sales and securitizations as well as potential new non-mark-to-market credit facilities. Lastly, in order to reflect current market conditions and to right-size our dividend yield, we have made the decision to reduce our quarterly dividend to $0.32 per common share payable on November 30, 2022, to common stockholders of record as of November 22, 2022. With that, I'll turn it over to Brandon.

Thank you, Sreeni, and thanks everyone for joining us. For the third quarter 2022, we had a GAAP net loss of $83.3 million or $3.40 per common share. Unrealized losses on our securitized loan portfolio contributed $1.58 or 47% of this GAAP net loss. Note that the return profile of the securitized loan portfolio is fixed upon securitization, but that the value of the underlying loans is used for GAAP reporting. Distributable earnings were $20.8 million or $0.84 per common share. The difference between GAAP and distributable earnings is primarily attributable to the add-back of unrealized losses on our mark-to-market loan and securitized loan portfolios as well as the impact of realized gains from interest rate hedges. Interest income for the quarter was $30.1 million, and net interest margin was $11.7 million as variable financing costs increased on our whole loan portfolio. As Sreeni stated, GAAP book value per share declined 27.8% to $10.63 as of September 30, 2022, down from $14.73 as of June 30, 2022. This includes the impact of our $0.45 per common share dividend paid in August. Economic book value, which includes valuing all securitization obligations to their fair value, was $12.94 per share on a diluted basis on September 30, 2022, down 19.4% from $16.05 per share as of June 30, 2022. Unrealized mark-to-market losses driven by rate and spread widening were the key contributors to the book value decline. During the quarter, we purchased $62 million of non-agency mortgages at an average loan coupon of 7.1%. The weighted average coupon of whole loans in our portfolio increased to 4.72% as of the end of the third quarter. The weighted average coupon across our securitized loan portfolio is 4.74% with a weighted average cost of funds of 2.72%. As we deploy capital into loan purchases, newly originated loans with coupons of over 8.5% will help drive up the weighted average coupon of the loan portfolio and improve securitization execution. As always, please note that due to the loan origination process, our loan purchases in a given month will typically reflect loan locks from 1 month to 2 months prior. Turning now to our securitization activity. In July, we were able to take advantage of a short window of opportunity to complete our fourth securitization since our IPO, a $185 million securitization, where we placed 86% of the capital structure at 5.8% weighted average cost of funding. The deal included 407 loans with a weighted average coupon of 5.22%, an average credit score of 730, loan-to-value of 75.1%, and a debt-to-income ratio of 32.1%. This transaction was rated by Fitch with the senior tranche receiving an AAA rating. This securitization deal freed up additional cash and reduced loan financing facilities by over $150 million. Our operating expenses for the third quarter were $11.5 million. When adjusted for severance and securitization expenses, operating expenses were $6.4 million, representing a savings of about $1 million versus the comparable $7.4 million in Q2, during which there was not a securitization. With regard to our balance sheet, at September 30, we had $20.5 million in cash and cash equivalents, and our recourse debt-to-equity ratio was 3.7 times. We have an unpaid principal balance of $1.3 billion of residential whole loans at a fair value of $1.1 billion; $1.1 billion of residential mortgage loans and securitization trust; and $1.1 billion of RMBS, including $65.4 million of retained AOMT securities from the pre-IPO securitization. We finished the quarter with undrawn loan financing capacity of $695 million. As of September 30, we had loan financing facilities with 6 financial institutions. After quarter end, one financing facility matured, and we added a new facility, bringing our total financing capacity to $1.4 billion as of today. As Sreeni mentioned, we plan to evaluate new facilities, including non-mark-to-market facilities. We remain committed to a sound liquidity management strategy during this period of rising rates. Finally, the Board has declared a $0.32 per share common dividend payable on November 30, 2022, to shareholders of record as of November 22, 2022. This implies an annualized dividend rate of $1.28 per share or a yield of 13% as of the closing price on November 7, 2022. For additional color on our financial results, please review the earnings supplement available on our website. I will now turn it back to Sreeni for closing remarks.

Thank you, Brandon. While the current market has presented challenges and has necessitated change, Angel Oak's fundamental differentiators have not changed. We are aligned with the most seasoned and experienced originators and the asset managers of non-QM mortgages, providing access to high-quality investments that meet our return and risk profile. We have a strong balance sheet that has proven its resilience among the unprecedented market dislocation so far this year. We performed superior credit underwriting, originating non-QM loans in any environment takes unique skills, and our diligent underwriting processes provide more insight into borrowers and risks. This has always been core to Angel Oak and will not change. We remain confident that our platform is uniquely positioned for success and look forward to continuing to capitalize on our strength in the future. As always, I would like to thank the entire Angel Oak team for their hard work and contributions to our successes. With that, we'll open up the call to your questions.

Thank you. Our first question is from the line of Don Fandetti from Wells Fargo. Please state your question.

What is your current cash position, and are you receiving any repayments on the loans that are not securitized?

Hey Don, I think the very first part of that question may have gotten cut off when you restarted.

No problem. Can you talk a little bit about your near-term liquidity position and your cash position and whether or not you're getting any repayments on loans that could help that position?

Yes, I think we've been in a situation for a while where we haven't been purchasing many loans due to significant market volatility. As a result, we've been using our liquidity to reduce debt and maintain a solid cash position. We currently have $20 million in cash, but we also have a substantial amount of unlevered securities and loans, providing us with the capacity to raise additional cash if necessary.

And would you consider selling loans? I wasn't sure if that was part of the sort of thinking of the portfolio?

Yes. No, I think you'll see, hopefully, this quarter, a few things. I believe that Sreeni touched on in his prepared remarks, we're always targeting to get securitizations out on a regular basis to the extent we can. That market has been very choppy lately. We are looking at selling a portion of the loans to move ahead, and that would free up a lot of liquidity that we can easily turn into significantly higher coupons as soon as that's done.

Dan, this is Sreeni, sorry. What we want to do is optimize our balance sheet for liquidity and also take some strategic actions. We have a combination of low coupons, and we don't want to lose our flexibility by just selling the loans because we aim to return them into a securitization, which we believe is the best execution. However, we are reviewing everything and optimizing our approach this quarter.

Got it, thank you.

Thank you. Our next question is from the line of Matthew Howlett from B. Riley. Please go ahead.

Thanks, good morning, thanks for taking my question. Just a few housekeeping. What's the UPB on unsecuritized loans? Is it the $1 billion plus the $9 million of commercial, what's the coupon?

So our UPB of unsecuritized loans is about $1.3 billion today, and that coupon is just over 4.7%.

Okay. And those have been presumably marked down here below par?

Yes. The fair value of those is about $1.1 billion.

Got you. Okay, and then the $1.1 billion in RMBS and CMBS, I mean how much of that is pledged to repurchase facilities?

About $60 million worth.

Got it. Brandon, when you mentioned that you hold the securitizations and keep some loans to par, if there are no credit events and losses stay within your expectations, could you provide an idea of where the book value would be? Also, what about the duration? What are we looking at in terms of duration?

Yes. What I meant to convey is that the unsecuritized loans are being marked down as interest rates increase. We anticipate that, assuming there are no credit events, these loans will ultimately be repaid at par. If all loans were to be paid off today, it would result in an increase of approximately 11 points in loan value, translating to a payment of $1.3 billion instead of $1.1 billion. This would represent a recovery of $200 million. Currently, the 4.7% coupon loans are prepaying quite slowly, so it will take some time to see progress on that front. In the interim, over the next several quarters, we plan to securitize these loans anyway, which should enhance our book value. I believe the execution of the securitization will offer more economic value to the company compared to a loan sale.

Thank you. I appreciate it. For my last question, there have been many headlines regarding Angel Oak Mortgage lending and Angel Oak asset management. Could you take a few minutes to update us on the activities at the parent company? Additionally, any information about personnel changes or key movements would be helpful.

Matt, this is Sreeni here. There's been a lot of conversations about everything Angel Oak. So at the Angel Oak holding company level, there's Angel Oak asset management and there's Angel Oak Mortgage company. So I'll go through Angel Oak asset management. There has really been no changes over there to speak of. We have mutual funds, and we have our private credit vehicles, and we continue to operate as normal. We face the same volatility as any fixed income markets, but that's not been any issue. We've had no issue across our funds in terms of financing lines or anything like that. That's on the asset management side. On the mortgage company side, the things that you hear, to be clear, we have a retail mortgage company and we have a wholesale mortgage company. The wholesale mortgage company does predominantly non-qualified mortgages, which is what we buy in the REIT and our other funds. And in the retail company, we did all sorts of things, including agency mortgages, which is actually predominantly what we did. So just like any other mortgage company, we had to shrink workforce over there, shrink what we do, but our focus on non-QM has not shifted. I would still speculate that, yes, our volumes are down as they would be in this environment. However, I would still speculate that we still originate more mortgages per lender than anybody else in this space. And that's primarily going either in our funds or hopefully in the REIT in the near future. So there's definitely shrinkage in the mortgage company, but nothing out of the usual in the asset manager.

Okay. So you're saying there have been traditional layoffs and just that, but are you still the leader in the space, especially in the league tables? I admit that some of your competitors have completely gone out of business.

Yes. And we came into this in a much better place. Obviously, we always have the partnership with the asset manager, which helps. We have raised the money. As we have always said that we are not an originate-to-sell model. We originate-to-own credit. Now that being said, as Brandon mentioned, the mortgage REITs had to be prudent on how they deploy cash in an environment where the rates are going up fast and furious. And so we thoughtfully slowed down our origination in the mortgage company because we wanted to preserve the cash in our funds along with the REIT. So we had definitely slowed down. But in terms of our credit underwriting, in terms of our operations, in terms of our people for non-QM, we haven't done any sort of shrinkage there.

Right, thanks guys, I appreciate it.

Thank you. Our next question is from the line of Derek Hewett from Bank of America. Please go ahead.

Good morning everyone. Could you talk about how GAAP book value has trended quarter-to-date given that rates have continued to grind higher?

Yes. From a duration perspective, these loans have a longer duration as interest rates have increased, which has caused the mark-to-market value of these loans to decrease alongside the book value. A significant portion of that rate impact is mitigated through interest rate futures. Additionally, the spreads have notably widened over the last few months. There were periods in the summer when spreads increased significantly, followed by a considerable tightening over a couple of months when there was a break in the rate pressure. However, this tightening was largely lost during the volatility in the rates market in September, returning to, or even exceeding, the wider spreads. This situation has contributed to the decline in the book value.

Okay. And then I'm not sure if you answered my question, but what about book value as of the end of October?

Yes, I mean, I think what Namit was getting at, and that's why I passed it over to him, it's just, we continue to see an environment where rates are increasing, spreads widening. So I would expect at the end of October, book value to be down another couple of points from where we are at the end of September.

Okay, great, thank you.

Thank you. Ladies and gentlemen, we have reached the end of the question-and-answer session, and I would like to turn the call back to the management for closing remarks.

Thank you, everyone, for your time and interest in Angel Oak Mortgage REIT. We look forward to connecting with you again next quarter. In the meantime, if you have any questions, please feel free to reach us. Have a great day.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.